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Outside the banking sector and its critics, not everyone
grasped the radicalism of Ed Miliband’s announcement a few weeks ago that the
next Labour government will establish
a network of regional banks. But this was policymaking at its best,
signalling a commitment to radically reform the relationship between finance
and the real economy and a determination to make Labour the party of small
businesses across the nation.

The British banking system is astonishingly uncompetitive: 89
per cent of all our businesses are dependent on the five major clearing banks.
Yet over the last 30 years these banks have become disconnected from the needs
of these businesses, seeking quick profits in the City and in the property
markets rather than long term investments in the industries and regions outside
the southeast. Duncan Weldon has
calculated that, in the decade before the crisis, 84% of the money lent to
British residents by British banks went into property and financial services.

The crisis has exacerbated this problem, with net lending to
businesses down by £4.5bn in the last quarter of 2012. Newsnight’s Paul Mason has
set out this problem
with regard to Barclays, one of the largest lenders to SMEs in Britain, showing
that the bank has reduced the amount it lends to non-finance, non-property
businesses by a quarter (from £52bn to £38bn) since the crisis hit in 2008. In
the process, Mason says, ‘the bank – single-handedly – has taken £3bn of
capital out of manufacturing, more than £3bn out of retail/wholesale, while
ploughing an extra £10bn into home loans and £6bn into property.’

The upshot is that many small businesses and entrepreneurs
across the country are struggling to access the finance they need to innovate
and grow, hampering economic recovery. The lack of long-term finance also makes
it harder for firms to make long-term investments in training, R&D or infrastructure.
Research
by the EEF found that more SME loan applications are unsuccessful in the UK
than in our main competitor countries, leaving most firms that wish to expand
dependent on credit cards and overdrafts with short term repayment conditions.
This has contributed to deeply-entrenched regional inequalities in the UK, with
business surveys finding regional disparities in both the provision of
unsecured lending and refusal rates.

Research conducted as part of Labour’s policy review has
also drawn attention to this problem. The final
report of the Small Business Taskforce – a group of leading businessmen,
entrepreneurs and academics commissioned by Labour to examine how to support
small businesses to thrive – highlighted widespread dissatisfaction with the
ability of the big banks to meet the financing needs of small businesses. Local
banking staff have long been stripped of the local knowledge or skills required
to make informed lending decisions, and many businesses complain that the power
to lend now rests with centralised credit teams that have no direct contact
with their customers and thus no understanding of their needs.

A key recommendation to emerge from the Taskforce was that
Labour should set up a new network of local banks to address these long-standing
issues, learning from the German Sparkassen system. The Sparkassen are restricted
to only lend to businesses and entrepreneurs within a defined geographic area,
and so are unable to pursue high risk investment strategies. They are commercially
run civic institutions that seek to support growth and innovation in their
local areas, not maximise profits for shareholders. And they are built on
well-trained staff that know and understand their customers.

There are many ways in which regional banks could be set up
and run in the UK context – but it is these principles that we should seek to embed
in the British banking system. If we succeed, Ed Miliband’s commitment to a
regional banking system, acting as the delivery arms to the British Investment
Bank we have already called for, could represent a life-line to Britain’s small
businesses, and the bedrock of a One Nation economy that is built by the many
and not just a few at the top.